Phone carriers still an oasis in a downturn

Commentary: High-dividend yields, consumer necessity limit risk

WASHINGTON (MarketWatch) -- Large phone companies might be glorified utilities, but their stocks are still a good place for cautious investors to park money in case of a downturn.

You wouldn't know it from the reaction lately on Wall Street. So far in 2008, the stocks of the six carriers with the largest dividend yields are down a collective 11% -- ranging from a nearly 5% drop in Embarq Corp. to a 22% decline in Qwest Communications International Inc.

Like all U.S. equities, phone stocks have been battered by talk of a recession, especially after AT&T Inc.'s chief executive said in early January that more customers were disconnected in December for failing to pay their bills.

The broad decline, however, gives an opening to investors who want to make a relatively safe bet and get a high yield at the same time.

Take Citizens Communications Inc.
CZN, +0.00%
The Stamford, Conn.-based phone company offers a dividend yield of almost 9%, well above the typical 3.5% rate on a certificate of deposit or the 3.9% rate on a 10-year U.S. Treasury.

Despite a dramatically changed industry landscape, though, the phone business is still largely inelastic. In other words, consumers need a phone.

Staying connected

Does it, really? For decades, phone stocks were viewed as safe havens during downturns. Yet some analysts and investors believe a fundamental industry shift to a competitive model from a monopolistic one may have sapped its attractiveness.

Customers, for example, now can choose from a variety of options. Phone and Internet service can be had from cable operators such as Comcast Corp.
CMCSK
and discount Internet-phone carriers like Skype or Vonage Holdings Corp.
VG, +4.82%

In particular, consumers seem to have become enamored with their wireless phones. Some are cutting the cord completely and going entirely wireless.

"One of the last things you will pry out of people's hands is their [cell] phone. Many other things will go first," Palm Inc.
PALM, +8.15%
Chief Executive Ed Colligan commented in an interview with MarketWatch.

The proliferation of new technologies such as wireless and broadband means there's room to pare back on monthly communications bills. Many consumers nowadays have traditional landline phones, high-speed Internet service and one or even two mobile devices. Cumulative bills often go well above $100 a month.

In a downturn, customers could cancel at least one account, choose a less-expensive monthly plan or move to cheaper, prepaid wireless service.

Despite a dramatically changed industry landscape, though, the phone business is still largely inelastic. In other words, consumers need a phone, even if just to look for another job. High-speed Net access increasingly is viewed as a household necessity.

Another factor that could limit defections or reduced spending by customers is the prevalence of bundles and contracts.

With bundles, customers receive sharp discounts when they buy a package of services -- usually local, long distance, Internet and perhaps even TV. In some cases, it could cost more to cancel one communications service and then pay for the rest à la carte.

"Certainly, I think all customers are going to have to make decisions about their overall telecommunications spend, and that's why bundling is so important to us," Windstream Chief Executive Jeff Gardner said last week on the company's fourth-quarter conference call.

Wireless plans, meanwhile, usually require one- or two-year contracts and carry high termination fees that could eat up any short-term savings from the cancellation of service.

The biggest threat for phone companies would be the loss of customers to rivals. Phone prices are generally quite modest, however, and cable operators don't offer significant savings. Alternatively, budget-priced Internet or wireless operators might benefit, but millions of customers are wary of unfamiliar brands and services.

So far so good

To be sure, phone companies are not immune to broad competitive or economic pressure. Revenue growth has been slow in recent years, especially for companies without wireless networks. All carriers also have been losing landline-phone customers, a trend that's put a cap on stock appreciation.

As a result, investors who seek big capital-gains profits are unlikely to find them in the phone business. What's more, stock prices could remain depressed in the case of national recession and if unemployment rose sharply. Some negative impact would be unavoidable.

Still, industry executives say they saw no material slowdown in the fourth quarter or even in the early stages of the 2008 first quarter.

Referring to a touch of softness in December, Qwest Chief Financial Officer John Richardson told MarketWatch: "One month does not make a trend."

After issuing solid fourth-quarter results on Thursday, CenturyTel Corp.
CTL, +2.19%
Chief Executive Glenn Post III said "we have seen very little impact on our business as a result of the economy."

Even AT&T has discounted the early-January remarks of Chief Executive Randall Stephenson, saying that investors blew his comments out of proportion. AT&T has stuck to its financial forecast for 2008.

Phone companies aren't without their own recession-proofing tools, either. Carriers have done a good job reducing expenses amid the shift to a more competitive industry, but they are not done yet. "There is considerable room to cut costs," according to Qwest Chief Executive Ed Mueller.

For all those reasons, executives are still sounding an optimistic, if cautious, clarion call to investors.

"I'm not a very good economist," Windstream's Gardner said, "but I do believe that these businesses are defensive."

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